Big Turnarounds in Heavy Construction?

07/19/2013 6:00 am EST

Focus: STOCKS

While most of the market has been on a tear, one sector that has particularly underperformed has been heavy construction companies, observes George Putnam of The Turnaround Letter.

The sector as a whole is slightly underwater for the year to date, and the stocks below are down an average of 10%. 

Part of this underperformance may be related to the weakness in the metals stocks; in addition, the sector appears to be weighed down by concerns about a slowdown in China.

Longer-term, the fundamentals for this sector look pretty favorable. In the US the real estate markets appear to be recovering, and in the public sector there is growing awareness of our need to rebuild our infrastructure. 

Globally, all of the emerging markets are likely to need extensive heavy construction in the years to come.

The heavy construction or machinery stocks below have all been under pressure recently, but have good long-term prospects.

Caterpillar (CAT)

Caterpillar has developed one of the strongest brands in the heavy construction industry.  Its operations span the globe with roughly two-thirds of sales outside North America. 

The stock has underperformed since early 2012 and made no net progress since 2006. A surge in mining activity that helped in 2010 and 2011 is now providing a headwind, as are general economic concerns about Europe and China. 

But management is responding by managing production schedules and cutting costs. The stock’s valuation and yield both look attractive.

Fluor (FLR)

Fluor is one of the world’s largest construction companies. The energy sector has been a bright spot for the company recently, helping offset challenges in the mining sector. 

Fluor also derives 44% of sales from industrial and infrastructure projects, which positions the company to benefit from future public sector infrastructure spending. The balance sheet is outstanding, and operations throw off strong cash flow.

Granite Construction (GVA)

Granite Construction, incorporated in 1922, is one of the nation’s largest infrastructure contractors and a producer of construction materials.

Poor operating results in recent years have kept the stock trading well below its 2007 peak and at the same level it saw in 2001. Management is responding by focusing on larger projects that are more profitable and by diversifying its portfolio of offerings. 

In addition, the late 2012 acquisition of Kenny Construction expands Granite’s presence in power, tunnel and underground markets. The financials are solid, and the stock is attractively valued with a decent dividend.

Joy Global (JOY)

Joy Global is a leading producer of mining equipment.  Sales of new equipment accounted for about 48% of fiscal 2012 sales with the balance coming from aftermarket equipment sales and servicing. 

Recent operating results have been soft due to the global weakness in mining activity. But profit margins are holding up, and management is well regarded.  While Joy waits for new equipment sales to rebound, it is benefiting from its aftermarket and maintenance operations.

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